9/15/2010 @ 1:25PM

Will Whistle-Blowing Be Millions Well Spent?

Sometimes the best intentions make the worst laws. This may be the case with the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act. A provision of the Act that rewards whistle-blowers who provide the Securities and Exchange Commission (“SEC”) with information relating to securities laws violations may present more headaches than viable information for regulators investigating violations.

Signed into law on July 21, 2010, the Act is a comprehensive overhaul of the financial regulatory system. It contains a whistle-blower provision that rewards individuals who provide the SEC with “original information” relating to violations of securities laws. The provision requires that whistle-blowers receive cash payments of between 10% and 30% of the fines collected for monetary sanctions exceeding $1 million and provides expanded protection against employer retaliation.

Enacted to prevent a recurrence of Madoff Ponzi scheme embarrassment suffered by the SEC for ignoring repeated warnings by whistle-blower Harry Markopolos (who first suggested the whistle-blower bounty program be extended to all securities violations during his 2009 congressional testimony), this provision would allow qualified whistle-blowers to potentially reap hundreds of millions of dollars in compensation.

This financial windfall is especially relevant for the Foreign Corrupt Practices Act. The FCPA prohibits persons and corporations from bribing foreign officials to retain or obtain business. Over the past few years, these investigations and prosecutions have escalated, resulting in massive settlements. To put the potential FCPA whistle-blower bounty into context, in the first six months of this year alone, the SEC and the Department of Justice (“DOJ”) announced FCPA penalties in excess of $1 billion–
BAE Systems Plc.
($400 M), ENI/Snamprogetti ($365M), Technip ($338M), Daimler AG ($185M),
General Electric
($23.5 M),
Innospec
($11.2M) and Alliance One Int’l ($10M).

It’s estimated the DOJ has more than 140 open FCPA investigations, including investigations announced by
Hewlett-Packard
and Avon. The SEC created a specialized unit in San Francisco to handle these cases. A number of issuers, including
Tidewater
,
Alcatel-Lucent
, Palapina and
Pride International
, have collectively reserved hundreds of millions of dollars of FCPA penalties. If a whistle-blower had been eligible for a 30% reward in the 2008
Siemens AG
settlement, which paid $1.6 billion in monetary sanctions to the DOJ, SEC and German government, the whistle-blower would have collected $496 million. Numbers like that will garner significant attention from employees, agents, foreign officials and contingency fee attorneys.

Given the amount of money at stake, one would expect that the parameters of the program would be well-defined. But this is not the case. For example, the amount awarded will be at the discretion of the SEC. Penalties, disgorgement and interest paid count toward the $1 million threshold. Factors to be considered in determining the amount of the whistle-blower reward include the significance of the information provided, the degree of assistance provided by the whistle-blower, and the programmatic interest of the SEC in deterring violations of the securities laws by making awards to whistle-blowers.

If the amount awarded is less than 10% or more than 30% of the monetary sanction, a whistle-blower may appeal the decision to the “appropriate court of appeals of the United States.” Given potential award amounts, it is highly likely that the SEC’s determination to decline to make an award will lead to an appeal. It should be troubling to the SEC and other related government agencies, that they would be required to litigate a behind-the-scenes look at how they prosecute cases, the value of particular evidence and whether and how the information presented by the whistle-blower was shared with other agencies. These appeals have the potential to be a tremendous distraction and resource drain for the SEC.

Under the Act, the whistle-blower could be a foreign official or foreign agent. If the SEC were required to make a 20 million whistle-blower payment to a foreign official, what would the political ramifications be? Foreign officials may find whistle-blower rewards a source of revenue worthy of reporting on colleagues or agents.

Taxpayers may also question why the government is so willing to take such vast sums of money out of U.S. enforcement agency coffers and reward it to whistle-blowers, particularly where there appears to be no shortage of current FCPA prosecutions and investigations

For the first time, individuals who come across evidence of suspected bribery of foreign officials will have a significant financial incentive to report it to government regulators. The whistle-blower incentive has the potential to drastically impact corporate internal investigations and voluntary disclosure decisions. Employees who once approached company auditors and compliance personnel with their suspicions may decide instead to go straight to the SEC.

Management and corporate counsel who uncover evidence of potential corrupt foreign payments will have to weigh the new incentives for employees when deciding how to conduct internal investigations and whether to voluntarily disclose the results of their investigations. An employee who learns through an internal interview that the employer is investigating potential FCPA violations may head straight to the SEC, impeding and disrupting the company’s attempt to ferret out improper payments. With the strengthened retaliation protections, employees who suspect a pink slip might seek whistle-blower status as a job security measure. On the enforcement side, the SEC may be diverted from warranted investigations as it attempts to manage an onslaught of allegations from disgruntled employees and insiders with little or no relevant information hoping to reap a huge windfall.

Given the enormous bounties whistle-blowers stand to collect, the ramifications of this provision will likely spawn a flood of allegations and an unforeseen quagmire of litigation with a cottage industry to support it. Once again, Congress has passed legislation without any thoughtful analysis of its consequences.

Michael F. Perlis is a partner with Stroock & Stroock & Lavan in Los Angeles and a former assistant director of the Division Enforcement of the Securities and Exchange Commission. He assisted in the original drafting of the FCPA. Wrenn E. Chais is Of Counsel at Stroock & Stroock & Lavan in Los Angeles, where she practices securities-related litigation.